Velan - $VLN.to

I mentioned Velan way back in 2010 when discussing excess cash on the balance sheet. Shares are down about 60% since then. 10 years and you've lost 60% of your wealth. This doesn't include dividends the company paid over the last 10 years. Depending on when you purchased you would have received $2.50-3.00 in dividends. You would still be down about 40% including dividends.

Background

Velan Inc. designs, manufactures, and markets industrial valves worldwide. It offers cryogenic valves comprising cast steel cryogenic, small forged cryogenic, cryogenic triple-offset, ball, and cryogenic control valves; gate, globe, and check valves, including pressure seal, cast steel, small forged, dual-plate check, bolted bonnet high pressure, cast stainless steel corrosion resistant, bonnetless, and knife gate valves, as well as maintenance valves for nuclear service; and quarter-turn valves, such as ball, metal-seated ball, forged ball, power ball, high performance three-piece ball, general purpose ball, triple-offset butterfly, high performance cryogenic butterfly, coker ball, and cap-tight batch digester capping valves. The company also provides cast steel and small forged hydrofluoric acid valves; and bellows seal bolted bonnet high pressure, seal cast steel, and seal API small forged valves. In addition, it offers bimetallic steam and thermodynamic steam traps. It serves power nuclear power, power generation, oil and gas, refining, chemical, pulp and paper, marine, mining, LNG and cryogenics, and water and wastewater sectors. It primarily sells its products through independent third-party distributors and sales agents. The company was formerly known as Velan Engineering Ltd. and changed its name to Velan Inc. in February 1981. The company was founded in 1950 and is headquartered in Montréal, Canada.

Market cap is 90mil US. EV is 88.9mil US. There are about 21.5mil shares outstanding. I'm using USD because that's the currency they report in.

The business has been around a long time. They have had several economic cycles to navigate and are involved in many different industries. Each specific industry as well as broader economic activity determines overall demand for the valves.

Business Performance

The top line hasn't moved much in the last 15 years. The business bounces around a fair bit, but they never run large losses for long periods of time.

Not big ROE and ROIC numbers, but again not negative. It may seem easy from the outside, but managing a business that isn't constantly growing can be more difficult than it seems. Managing expenses and having hard conversations with stakeholders is not fun. The operators of this business deserve some credit for keeping costs in line with revenue.

Mgmt

The CEO has been with the company since 2015. He has about half of his total compensation in common shares.

The Velan family is peppered throughout the business. There are 3 family members on the board, including the Chair. The CEO, CFO and many senior executives in charge of operations are not from the Velan family.

Share Structure and Ownership

There are 15,566,567 Multiple Voting Shares (“Multiple Voting Shares”) and 6,019,068 Subordinate Voting Shares (“Subordinate Voting Shares”) of the Corporation were issued and outstanding. Each of the Multiple Voting Shares carries the right to five votes per share and each of the Subordinate Voting Shares carries the right to one vote per share.

Velan Holdings Co. Ltd (“Velan Holdings”) owns all the multiple voting shares and controls the direction of the company. Some other funds own collectively 15% of the Subordinate Voting Shares. The board owns 0.2% of the outstanding shares. Non Velan family members own 86k shares or about 0.3% of the company.

Valuation

As with most of the company's I have mentioned recently, this isn't the software compounder bro stock. This is an traditional industrial business.

The company is currently trading at less than NCAV of $6.75/share. It has traded below NCAV before during the GFC. This is not a company that trades as a perennial net-net.

The company has a current assets of 387mil. 95% of current assets are cash, receivable and inventory. That includes 87mil is in cash, 117mil in accounts receivable and 166mil in inventory.

Total Liabilities are 241mil. There is a mix of tax, payable, accrued short term liabilities, customer deposits and debt.

I think looking at working capital to revenue, asset turns and the cash conversion cycle give an idea of how this business operates. Given that this company is trading so cheap (below NCAV), the goal is to make sure that our investment thesis does not revolve around a business with obsolete inventory, receivables that are unlikely to be collected or some form of liquidity crunch in the short term.

After the end of the last quarter the company sold a plant in Montreal for 12.6 mil gross. The sale will be effective Oct 31, 2020 and is subject to the plant receiving a clean environmental report.

Dividend has been cut to conserve cash.

Backlog

The company's backlog has come down in the last few years, but still stands at just over 400mil. This provides some visibility on activity and overhead cost absorption.

V20 Transformation Plan

The company started the V20 plan in January 2019. They are progressing ahead of schedule and starting to see some benefits to operating results from the plan.

I've been an employee when a business has done a major restructuring and it can be confusing when you are just an individual contributor in a large organization. Given how much attention this gets in the annual reports, investor presentation, conference calls and updated website information helps build confidence that every employee is kept up to date.

Covid

They were deemed an essential business, though they did have some disruption. The CEO does weekly videos to share updates with the entire organization, which I thought was a good example of leadership. Given the large backlog and V20 initiatives, they have not been hit as hard as I would have thought. It's uncertain what the long term impacts are on the economy from covid and the lockdowns are at this point.

Risks

• there are also some employment agreements with senior officers that need to be kept in mind

• demand for their products can be affected by the economy

• illiquid and hard to build a position and exit if needed

• controlled by the Velan family

Conclusion

Expectations are really low and the business is cheap on an earnings and asset value. I have pivoted my thinking around net-nets. I like how Geoff Gannon phrased it when talking about net-nets on the Focused Compounding Podcast. (I would link it but I'm sure which one because they post so much lol). He essentially said "would you lend this business money?" I would lend Velan my capital.

These small companies trading at such cheap valuations can stay cheap forever. Management has taken steps to align expenses, serve customers and preserve the balance sheet. These companies generally do rerate, but who knows when.

Anyone else finding some net-nets out there?

Thanks,

Dean

*the author is long shares of $VLN.to at time of writing